Factors that affect the cost of private renting

Readers Question: I was looking for info on housing demand/supply. One area you have no info on is rental trends. There is a lot written about a critical housing shortage in the UK, starting with the Kate Barker review (2004), who took great pains to assure anyone who asked that UK house prices could only go up because of supply/demand fundamentals. None of her projections have been achieved and, if her assumptions were right, there should be an acute housing shortage, evidenced by rising rocketing rental rates, and middle-class homeless, sleeping on the street. Anecdotally, I don’t see any manifestation of exponential inflation of rents eg a 2 bed apartment in the commuter belt outside London attracted rent of c. £1,000 pm in 2002. In ten years that has risen marginally. Why, if there is a critical housing shortage?

In recent months, there has been a marginal increase in house price rents in UK.

In the 12 months to August 2013 private rental prices paid by tenants in Great Britain rose by 1.2%. Private rents in Great Britain excluding London rose by 0.8% during the same period.

In the 12 months to August 2013 private rental prices grew by 1.1% in England, 1.3% in Scotland and 1.3% in Wales.

Index of renting

I used statistics for England rents because the data went furthest back. Data for the UK started later. Source: ONS

This shows a modest rise in the cost of house price rents. A rough calculation suggests an 8-9% rise in rental prices, slightly lower than the rise in the Consumer price index.

House price v rental costs

An interesting comparison is to compare house price inflation with the increase in rental prices.

One very clear feature is that house price inflation is much more volatile than rental prices. Rental inflation, has rarely risen above 2%, House price inflation has reached over 10%, and slumped to -13%

In this period since 2006, house prices have risen by an average of 2.4% . Rental prices have risen by an average of 1.0%

However, it is worth bearing in mind that in the period 2000-2006 house prices were increasing by up to 20% a year.

In a way, it is remarkable, that house prices have risen by an average of 2.4% since 2006 – given the credit crunch, the depth of the recession and especially when compared to other countries which have had a real housing slump, such as Spain and the US.

UK House prices to rental costs

The Federal Reserve have an interesting graph which shows how house prices in the UK have risen much more substantially than UK private rents, in the period 1996-2008.

FRB on UK House prices (2008) It was interesting the FRB report suggested ‘Using the price-rent ratio as a guide, (UK) house prices are likely to fall at least a further 30 percent before levelling off.’

Why are rental prices more stable than house prices?

Some factors that could explain why UK house prices have been rising faster than rental prices.

Many tenants have longer term contracts. Landlords may enter into agreements (either formal or informal) to keep rental prices fairly constant. House prices, by contrast, are driven by supply and demand. If more people enter the market for buying a house, it can push prices higher. If house prices rise 20%, it doesn’t mean homeowners will see a 20% rise in the cost of mortgage payments. Most homeowners will be unaffected in the short term by rising house prices. Renters will be affected directly by any change in the cost of rent. Most renters couldn’t afford more a sharp jump in rents.

Rents not affected by interest rates. If interest rates go up, this doesn’t change the cost of renting. But, it might dissuade people from buying a house. Similarly if interest rates fall, landlords will not pass the interest rate cut onto tenants.

Supply more elastic. It is likely that rental properties are slightly more elastic than houses. If there is greater demand for renting, and the price of renting goes up, it may encourage more landlords to put houses for rent on the market or it may encourage people to let out a room. However, this point is just an assumption – it would need a bit more investigation.

Demand more price elastic for renting. If rents rise in London, it may encourage workers to move elsewhere to find cheaper rents. Renters are more flexible and more price sensitive. If you want to buy a house in a certain area, you’re demand is more likely to be price inelastic. If house prices go up, you may be willing to pay the higher price – you don’t notice a price rise straight away. Higher prices are spread over the 30 years of the mortgage term.

Buying houses as investment. Rising house prices have encouraged more people to buy houses as an investment. This pushes up house prices, but consequently leads to an increase in the supply of rented accommodation. Therefore, you could have a situation where a sharp increase in buy to let activity, pushes up house prices, but decreases rental prices. Evidence suggests the % of homes which are owner occupied has declined in recent years; this could imply an increase in the supply of homes put on the rental market.

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